After four decades, FedEx turns the page with $1.65 billion operational revamp

For more than 40 years, the domestic air express business has been the tail that's wagged
the dog at FedEx Corp.

Its founder, Frederick W. Smith, was more comfortable in the cockpit than in a rig, once remarking,
"to us, truck is a four-letter word." FedEx earned its legendary reputation by flying letters and packages,
not by trucking them. Corporate strategy was influenced—and decisions made—mostly by those with backgrounds
in the air industry. Even as demand for air services in the U.S. entered a secular decline, the company's
air unit continued to grow, not retrench.

Those days appear to be gone.

In one of the most significant steps in its history, Memphis-based FedEx announced a three-year,
$1.65 billion restructuring that marks a fundamental shift in emphasis from its domestic air business
to its surface transport, international forwarding, postal, and international express operations. The
company expects to achieve most of the savings in two years.

About $1.55 billion in savings and efficiency improvements will come from the Express unit, which remains the company's
largest by revenue. Of that amount:

$400 million will come from internal expense reductions that will involve, among other things, voluntary buyouts and attrition

$350 million from adjusting its network infrastructure to optimize freight flows and volumes

$350 million largely from growing its international business, and

$150 million from expanding into high-demand vertical industries such as health care.

Company executives said that while they don't expect large volume declines in the U.S. air express market, they
understand that it is no longer a growth segment.

By contrast, the company's fast-growing ground parcel unit, "FedEx Ground," will expand its
network capacity by 45 percent over the next five years to handle expected gains in demand and
market share. However, most of the work will be done without the unit's current-CEO, David F.
Rebholz, who will retire in May after running the operation since 2007. A successor has yet
to be named.

In addition, FedEx said its less-than-truckload (LTL) unit, FedEx Freight, is experimenting with
alternate forms of pricing in a bid to move away from "classification" prices that are determined by
the characteristics of commodity classes. For decades, shippers who've tendered shipments classified as
"freight, all kinds" (FAK) have enjoyed rate windfalls because carriers have routinely mispriced that
type of freight class.

The problem for carriers has been worsened by the growing role of brokers and third-party logistics
companies (3PLs) that tender large volumes of FAK freight and can use their clout to beat back any
attempts at price increases.

William J. Logue, head of FedEx Freight, said in an
interview earlier this year that LTL carriers must eventually move away from class pricing towards a more simplified
structure based on shipment distance and density. Logue said at the time that such a transition would be long and difficult,
and analysts attending two days of meetings in Memphis said industry pricing is unlikely to change in the near term.

A PROFOUND SHIFT
The moves announced by Smith on Tuesday and Wednesday are as much a profound cultural shift as they
are economic. They reflect upper management's acknowledgment that it can no longer protect the air
business from a world which has morphed—perhaps permanently—into one where speed-to-market is no
longer the driver of customers' buying decisions.

Jeffrey A. Kauffman, transport analyst for the Birmingham, Ala.-based brokerage Sterne Agee said the actions underscore
"a change in philosophy at the top levels" driven by those a bit down below who work in the daily trenches. The U.S. express
business "has been a sacred cow at FedEx, but this change marks an admission that the world has changed, and that the network
FedEx built must change as well," Kauffman said in a research note.

According to analysts at the meeting, Smith and other top executives took pains to underscore the relentless
"trading down" of transportation modes by shippers as they realign their supply chains to adjust to a slow-growth
economic environment here and abroad. Domestically, less expensive truckload has taken share from LTL, while ground
parcel has become, for many shippers, a cost-effective substitute for air freight.

Internationally, the traditional air-freight business, which is defined as airport-to-airport service mostly managed
by air freight forwarders, is feeling pressure from two sides. It's being squeezed on price by cheaper ocean services. At
the same time, it's also being squeezed on service by air express, which—in spite of its premium prices—has proven to be
invaluable to shippers of high-value commodities that want to avoid inventory obsolescence. Smith has said he sees little
or no growth in the traditional airport-to-airport business.

Perhaps the most striking example of customers trading down in mode is at FedEx Freight. There, 14
percent of its linehaul miles are today moving via lower-cost rail service. By contrast, just 2 percent
of the unit's linehaul miles went by rail prior to a 2011 reorganization that segmented service into two
categories: one for priority deliveries and another for slower, less-expensive economy service.

Most analysts believe FedEx, which disclosed that it is already a year into the process, can hit its goals. David G. Ross,
analyst for investment firm Stifel, Nicolaus & Co., said FedEx's analysis and the reasoning behind it are rational. Kauffman
of Sterne Agee believes the plan will succeed because it is mostly cost driven and doesn't involve cutting into the bone of
the enterprise. "[It] doesn't take a better economy or unspecified revenue synergy to be successful," he wrote.

That said, the total savings might be higher or lower than currently forecast depending on U.S. and international economic
conditions, and the future path of oil prices.

William Greene, transport analyst for Morgan Stanley & Co., may have spoken for many when he called the plan "surprising
in magnitude." And Greene may have spoken for all who follow FedEx when he wrote that although an economic downturn might
limit the company's ability to achieve its desired cost-savings, "management's willingness to acknowledge and address the
secular challenges afflicting the Express market is a positive in itself."

We could all use some positive news and thankfully we have some for you: Many signs are showing that the freight markets are starting to recover.
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